Rights of brokerage customers on the line in high-court test
Sometime in the next few months the United States Supreme Court will rule on whether Eugene and Julia McMahon have the right to sue their broker, Shearson Lehman Brothers. Oral arguments were heard this month. This case could set a precedent that would jam the courts and cost the brokerage industry millions of dollars if the Supreme Court decides in the McMahons' favor.
At issue is whether a brokerage contract that requires all future disputes to be arbitrated amounts to an unconstitutional suspension of a customer's right to due process. Current law governing securities disputes ``is really a mess,'' says G.Richard Shell, a professor of legal studies at the Wharton School of University of Pennsylvania.
The Supreme Court has ruled in previous cases that:
Alleged violations of state laws covering securities fraud can be sent to arbitration.
Alleged violations of the Securities Act of 1933 (covering initial public offerings) should go to the courts, not arbitration.
Alleged violations of the Securities Act of 1934 (covering securities in the secondary market) involving international securities cases should go to arbitration.
The lower federal district courts have gone both ways on cases involving the Securities Act of 1934. The position of the Securties and Exchange Commission has been similarly inconsistent. For years, the agency pushed brokers to remove arbitration as a standard contract feature, but now the commission endorses arbitration.
The advantage of arbitration is that it is quicker and saves both sides money. Arbitrated disputes are often settled in 10 months. Court battles often take years, and lawyers' fees can eat up a large portion of the settlement, if awarded.
The big disadvantage is that arbitration decisions are final. Once a claim is heard by an arbitration panel, the investor or broker loses the right to take the dispute to court.
There is no appeal, no explanation of how the decision was reached. There is no pretrial discovery process, either, so a disgruntled customer cannot build his case on brokerage house records. And, in some states, no punitive damages are awarded.
Professor Shell hopes the court rules in favor of arbitration. ``That decision would go a long way toward picking a consistent forum for disputes.''
If arbitration becomes the primary forum (or even if it does not), Shell contends, the Securities and Exchange Commission, Congress, or both must make the arbitration process fairer for investors and more capable of dealing with federal statutes.